Accounting: Tools for Business Decision Making, 5th Edition

by
Kimmel, Paul D.; Weygandt, Jerry J.; Kieso, Donald E.

Answer

The decision to take the new equipment on lease instead of buying it, will certainly prove beneficial as the following advantages of leasing will be available:
a) Reduced risk of obsolescence: The terms of lease allows the lessee to exchange the asset, when it becomes obsolete.
b) Little or no down payment: If a company has to buy assets, it has either to pay full cost immediately or pay a down payment of 15-20% of the cost and get the balance amount financed.
c) Shared tax advantage: New companies do not make much profit in first few years and therefore they will not be able to use the tax advantage from purchase of the asset.
d) Assets and liabilities not reported: Companies prefer to keep the assets and liabilities, as minimum as possible in their books of accounts.

Work Step by Step

a) This is an easier way to get rid of an outdated asset instead of selling it and buying a new one.
b) In case of leasing, there is no requirement to pay a down payment, as the assets is purchased by the lessor.
c) Hence the asset is purchased by the lessors, who takes the benefit of tax advantage on the asset, and pass it on to the company.
d) It will give better assets turnover ratio and return on assets ratio. Since the liabilities are less, the company looks less risky. Hence by keeping the assets and liabilities off the balance sheet will give the company benefits in improving the ratio and financial strength of the company. Therefore companies prefer to take the asset on lease than to purchase it.